Cleaned books, dirty streets Image via Nepal News
In the cafés of Kathmandu, where gossip is traded with the same fervour as stocks, the mood among ever-grumbling bankers has shifted overnight from panic to a guarded relief. For years domestic lenders have sat on a pile of cash they could not lend, watching bad loans pile up like drift ice in a freezing economy. Now the mandarins at the Nepal Rastra Bank, the country’s central bank, have offered a thaw. A fresh raft of regulatory tweaks, issued on December 15th, promises to massage the bruising figures on bank balance sheets. Yet while the ledger may look cleaner, the shop floor remains worryingly empty (see this).
The context is a classic liquidity trap. Banks are awash with investable funds—excess liquidity hovers near record highs—but credit demand has collapsed. A stagnant construction sector as well as slumping manufacturing, among others, have left the economy gasping. Consequently, non-performing loans (NPLs) have crept up, threatening to breach the central bank’s comfort zones and eating into distributable profits (see this).
The NRB’s solution is essentially an exercise in regulatory forbearance. It is a masterful, if cynical, piece of administrative surgery designed to sever the link between economic stagnation and reported banking health.
Consider the treatment of “bad” loans. Previously, if a loan went sour and the bank initiated an auction to recover collateral, the asset was branded “bad” regardless of what happened next. Under the new rules, if the borrower manages to scrape together a repayment after the auction gavel has been raised, the loan can be pulled back from the brink and reclassified as good. It is a logical tweak, but one that allows banks to flatter their NPL ratios without the underlying business climate actually improving.
More significant is the lifeline thrown to “national priority” projects—the hydropower plants, cable cars, cement factories and hotels that form the spine of the country’s industrial ambitions. These sectors are currently heavily leveraged and suffering from cost overruns. The NRB has decreed that loans to these projects can be restructured or rescheduled, provided they are active, with a mere 1% loss provision set aside. In the past, restructuring a loan usually meant acknowledging it was distressed, needing hefty provisioning that decimated profits. Now a struggling hydro project can be refinanced and effectively treated as a standard asset.
This is a gift for the banks. It prevents capital erosion and keeps the dividends flowing. For the economy, however, it risks creating a nursery of zombie firms: companies that can service the interest on their debt only because the regulator has allowed the terms to be softened, rather than because their cash flow has been strengthened.
The central bank’s approach to “Non-Banking Assets” (NBA)—collateral the bank has repossessed—shows a similar sleight of hand. Banks must now try to auction property three times before taking possession, and the punitive 100% provisioning requirements for holding these assets have been relaxed. This prevents forced fire sales that would crash the real estate market, a sector that underpins nearly all banking collateral. It stabilizes property prices by fiat rather than market dynamics.
Yet for all this supply-side tinkering, the demand side remains strangled. The NRB maintains strict Debt Service to Income (DSI) ratios—50% for personal loans and 70% for housing. Although prudent, these caps mean the average Nepali, whose real income has been sapped by inflation, cannot borrow to consume. The rules also tighten the screws on governance, demanding that banks form “Asset Purification” committees and requiring board approval for executives’ foreign travel—a micromanagement tactic suggesting the regulator trusts bankers’ integrity as little as it trusts their loan books.
The sorry logic of NRB’s latest intervention hits you in the face. By allowing banks to reclassify distressed loans and easing the rules on repossessed assets, the central bank has ensured financial stability on paper. The banks will likely report healthier profits this quarter; the screaming headlines about rising NPLs will fade. But the transmission mechanism to the real economy is broken. A cement factory does not fire up its kiln just because its loan was restructured; it does so when someone wants to build a house.
Until the government tackles the structural bottlenecks—slow capital expenditure, as well as political instability and a lack of business confidence—the central bank’s circular is merely a sophisticated accounting shield. It protects the banks from the economy, rather than using the banks to jump-start it. Investors and depositors may sleep better knowing the banking system is stable, but they should not misread a clean balance sheet for a flourishing marketplace. ■
